Corporate Research E-Letter No. 53, May-June 2005
BROKEN PROMISES: THE BUSINESS ASSAULT ON "LEGACY COSTS"
By Philip Mattera
In most contexts, the term legacy has a positive connotation. World leaders praised John Paul II’s legacy after the Pope died earlier this year. Conservatives are promoting the Reagan Legacy Project to ensure that the President they venerate is adequately commemorated. At many colleges, legacies (children of alumni) are given preference in admissions. And the basic meaning—a bequest of property—is something that can transform an heir’s life.
In the business world, however, legacy has become a pejorative term—almost a slur. The larger, more established airlines are no longer called the majors; they are described as legacy carriers, to distinguish them from nimble upstarts such as Jet Blue. Industrial giants in sectors such as automobiles, steel, rubber and chemicals are said to be weighed down by legacy costs, especially for healthcare. The credit rating service Fitch recently cited such costs when downgrading General Motors bonds to junk status. Legacy has become shorthand for referring to corporations that are in trouble and heading for bankruptcy, or worse.
At the root of that trouble, we are told, are excessive labor costs. The legacies that are said to be crippling the industrials are pension liabilities, retiree healthcare commitments and other obligations to current and former employees. Business is no longer simply complaining about these costs; it is beginning to take action. The recent move by United Airlines to terminate its pension plans can be seen as a part of a growing campaign by Corporate America to liberate itself from past promises, whatever the social consequences.
ABANDONING OLD WAYS OF DOING BUSINESS
The use of the term legacy in the business world used to be limited mainly to the phrase legacy systems, which referred to outdated computer technology. Companies often had to keep such systems in place, because it was prohibitively expensive to convert the large quantities of data they contained. But as soon as it was feasible, the old technology was unceremoniously junked.
Today’s criticism of legacy costs views labor-related obligations in the same general way—as burdens tied to outdated ways of doing business. And the clear message is that corporations should try to free themselves of those burdens in the same way that they dumped their old mainframe computers.
What is obsolete, according to this way of thinking, is the practice of providing employees with good wages and benefits. The attack on legacy costs thus comes down to an assault on the improvement in living standards that workers won over the course of decades, usually with the aid of labor unions. What was once seen as an enhancement of the quality of life is now depicted as a social evil.
Among the various legacy costs, the ones that draw the most fire are pension obligations. In the period after the Second World War, it became common practice for all but the smallest employers to set up retirement plans for their hourly and salaried workforce. Unions frequently accepted smaller wage increases in exchange for enhancements to pensions that would benefit their members in the future. Private pensions came to be regarded as an essential supplement to Social Security payments.
As was discussed back in E-Letter No. 38, the first business forays against traditional pensions came about a quarter-century ago. During the 1980s, many companies terminated retirement plans and took possession of the “excess assets” to finance acquisitions and leveraged buyouts. Faced with a public outcry, Congress effectively put a stop to what was widely known as pension piracy.
By that time, however, more and more employers were ceasing to offer their employees traditional pensions (defined-benefit plans that provide a guaranteed amount of money each month, based on previous pay and length of service) and were replacing them with defined-contribution benefits, usually in the form of 401(k) plans. Strictly speaking, the latter are not pensions. They are individual retirement accounts into which the employer makes payments. The value of those accounts is subject to the vagaries of the financial markets, and the employer has no obligation to make sure that the amount the worker ends up with is sufficient to provide a decent standard of living after retirement.
This change in the meaning of retirement benefits is now well known; in fact, most younger workers probably don’t realize that pensions used to entail guarantees rather than uncertain investments. Yet defined-benefit plans still exist for a significant number of older workers. About 20 percent of the U.S. private-sector workforce participates in such plans (and the rate jumps to 69 percent for unionized workers).
Many employers, unfortunately, no longer see their remaining defined-benefit pension commitments as a solemn obligation. Instead, they seek ways to shirk their responsibility. One well-established way of doing this is through accounting manipulation. Most private pension plans are employer-managed, meaning that companies can play games with the amount of money contributed to the plans each year; for example, by projecting an unrealistically high rate of return on assets already in the plan. Last year Congress enacted legislation that made it easier for companies to reduce their contributions legally.
Alternatively, a firm may decide that it is not actually responsible for a particular retiree’s benefits. The Wall Street Journal recently reported on a trend among companies to deny responsibility for paying the pensions of certain workers who had joined their payroll as the result of a merger or takeover. Corporate pension administrators are being asked to do audits that often conclude that an individual’s payments should have been coming from some other entity, which might now be defunct. Not only does the company then cease sending checks; it may also pressure the recipient to repay past benefits.
Even more shocking was the recent ruling by a federal bankruptcy court judge that United Airlines could terminate its pension plans covering some 134,000 workers and retirees. Last year, United stopped making contributions into the plans, thus exacerbating an underfunding problem that reached nearly $10 billion. The plans are being taken over by the federal Pension Benefit Guaranty Corporation, which itself has a balance-sheet deficit of more than $20 billion. United’s pension participants, like those of most other terminated plans, will almost certainly have to accept significant reductions in their benefits. In fact, there is the possibility that the United takeover—the largest in the PBGC’s history—will prompt similar moves by other airlines and auto companies that could overwhelm the agency.
Another legacy under attack involves retiree health benefits. Starting in the late 1960s, large employers began negotiating such benefits with unions as a supplement to Medicare. Many salaried workers were given similar promises of coverage for life. Once medical costs began escalating, business began to look for ways to escape these obligations. During the 1990s, many corporations pressured unions to agree to cuts in the benefits or the shifting of costs to retirees. Those firms that found themselves in Chapter 11 got permission from the bankruptcy courts to eliminate the benefits entirely.
Over the past few years, companies have become even more aggressive. Some, such as Lucent Technologies, told retirees that they would have to shoulder the entire cost of the coverage. Many others used the passage of a Medicare drug benefit as a pretext for scrapping their own coverage. Last November the Wall Street Journal reported that companies were suing individual retirees receiving health benefits under union contracts. The aim was to find sympathetic judges who would go along with the dubious argument that promises of lifetime benefits actually referred only to the life of the contract, not the life of the worker.
The latest onslaught is against the retirement health benefits of public-sector employees. A recent article in Fortune described the commitments made to such workers as “a time bomb quietly ticking away in the netherlands of state and local government.” Apparently, giving retired firefighters access to quality health coverage is now a form of fiscal terrorism.
Whether in the private or the public sector, the campaign against legacy costs is at root an effort to undo the results of collective bargaining. It is thus no surprise that another aspect of the campaign is a direct assault on union rights. A number of companies in Chapter 11 have been using the bankruptcy court not only to terminate benefit plans but also to undo the provisions of labor contracts—a drastic step not seen much in the past twenty years.
Last year, Horizon Natural Resources, a coal company, received court permission to cancel its contract with the United Mine Workers in order to make the company attractive to a potential buyer. A few months later, Ormet Corp. was allowed to nullify two contracts with the Steelworkers union at aluminum plants in Ohio.
The struggling “legacy carriers” in the airline industry soon sought to do the same. Last November, US Airways filed a request in bankruptcy court for permission to terminate collective bargaining agreements covering 20,000 workers represented by three unions. A few weeks later, United Airlines asked to abrogate contracts with six bargaining units. For the airlines, the requests were mainly a way of playing hardball in labor negotiations on concessions. In most cases, unions responded to the threat of termination by agreeing to substantial wage and benefit cuts—though the Machinists waited until after a judge had given US Airways permission to terminate the contract.
Efforts by companies to terminate collective bargaining agreements are the clearest sign that the corporate effort to free itself from legacy costs is aimed at reducing the power of workers and redistributing income from labor to capital. The purported justification for this is that the companies involved are in financial distress. That may be an excuse for layoffs or even contract concessions, yet commitments such as pensions are another matter. Employers had a fiduciary duty to protect those benefits, regardless of the ups and downs of the market. After violating that duty by underfunding retirement plans for years, they are now seeking to be relieved of the obligation.
This is a basic betrayal of trust that should not be tolerated. Yet the idea of reneging on commitments to workers is popular in certain quarters these days. That is essentially what the Bush Administration’s call for Social Security “reform” is all about. Like his corporate counterparts, Bush is treating the benefit promises made to millions of Americans as unsustainable legacy costs that have to be abandoned. In both the public and private sectors, obligations that were once regarded as absolute are now being treated as an impossible luxury. In the great American economic inheritance, more and more of us are being cut out of the will.